making sense of financed emissions – Financial institution Underground

Lewis Holden

Over 95% of banks’ emissions are ‘financed emissions’. These are oblique emissions from households and companies who banks lend to or put money into (banks’ asset exposures). Banks disclose these according to rules designed to assist markets perceive their publicity to climate-related dangers and their impression on the local weather. However emissions disclosures range drastically between totally different banks with related enterprise fashions. Knowledge high quality and availability is cited as the important thing cause for this. On this submit, I exhibit that variations in financed emissions estimates are defined by the extent of banking actions and asset exposures fairly than information high quality and availability. For instance, whether or not estimates seize a subset of mortgage exposures or wider banking actions similar to bond underwriting.

Evaluating financed emissions between banks might be difficult as a result of financed emissions scale with asset exposures. In Desk A, I summarise financed emissions from a subsample of globally systemically essential banks (G-SIBs) disclosures. For comparability, G-SIBs in Desk A are of comparable dimension.

Desk A: G-SIB financed emissions

Sources: G-SIBs’ climate-related disclosures and annual studies for monetary years ending 2024.

How can these G-SIBs, which all function globally with related enterprise fashions and asset exposures, report financed emissions an order of magnitude totally different from each other? Knowledge high quality is normally cited as the important thing obstacle to accuracy and comparability. As an example, emissions disclosures point out ‘information high quality’ or ‘information hole’ a median of 10 instances. However is information actually the core problem?

The information argument goes like this. Households and companies which banks lend to and put money into should disclose emissions earlier than banks can mixture these to calculate financed emissions. However the majority of banks’ asset exposures are households, customers and unlisted corporates that don’t disclose their emissions. As a result of disclosure necessities solely apply to giant, listed corporates. Giant, listed corporates predominantly entry finance by way of capital markets fairly than loans. Due to this fact, banks have to estimate the emissions of the households and companies who make up their asset exposures to be able to calculate financed emissions.

Is information high quality and availability the supply of variation?

I evaluate three totally different financed emissions estimates for a pattern of UK banks:

1. Reported in banks’ local weather disclosures.
2. My estimation mannequin, with proxy emissions information provided by information supplier A.
3. My estimation mannequin, with proxy emissions information provided by information supplier B.

The information suppliers I take advantage of are MSCI and LSEG. The estimate relating to every supplier has been anonymised. Broadly, my estimates seize banks’ company and mortgage mortgage exposures, as beneficial by the Partnership for Carbon Accounting Financials (PCAF). PCAF is the business customary steering for measuring financed emissions. Different exposures, similar to client finance, and different banking actions, similar to bond underwriting, are excluded.

Within the absence of granular mortgage stage information, my estimation mannequin assumes banks’ debtors might be proxied by a median. For instance, loans to the UK transport sector are proxied by the imply carbon depth for UK transport corporations which disclose emissions information. This mannequin has been developed by Financial institution employees and was utilized in The Financial institution of England’s climate-related monetary disclosure 2025.

Chart 1: Financed emissions disclosed by UK banks and estimated from my mannequin

Sources: Banks’ climate-related disclosures and annual studies, MSCI and LSEG.

Regardless of the vary of emissions information sources, proxies and aggregation strategies, estimates fall inside a spread of round 10%. This means the selection of emissions proxy information, and the way estimation fashions mixture this information, has a restricted impression on aggregated financed emissions estimates.

Variations in financed emissions on the particular person counterparty stage could also be extra divergent. For instance, the European Central Financial institution demonstrated that banks estimate a variety of emissions for a similar counterparty. My evaluation doesn’t dispute this. It merely demonstrates that when aggregated, financed emission estimates naturally converge in the direction of the imply.

If information high quality and availability don’t drive variations, what does?

The important thing driver of variance in financed emissions estimates is solely extent of enterprise actions and asset exposures which banks estimate emissions for. I describe this because the ‘boundary’ of the estimate.

In Chart 1, I intentionally chosen a subset of banks’ emissions reported on the idea of the identical boundary as my mannequin. This managed for the boundary impact and remoted the impact of information high quality and availability.

Nonetheless, banks don’t persistently disclose financed emissions on the idea of the identical boundary. I establish three broad classes of boundary in opposition to which emissions might be estimated:

1. Minimal boundary – an estimate for a subset of mortgage exposures. Usually these deemed excessive local weather danger, similar to to grease and gasoline firms.
2. PCAF boundary – an estimate masking most mortgage exposures. Excludes some loans with unknown use of proceeds, similar to client finance.
3. All actions boundary – an estimate for all actions banks undertake and all asset exposures. Along with loans, this will likely embrace ‘facilitated emissions’ – eg from bond underwriting, in addition to property managed on behalf of shoppers and never owned by the financial institution.

In Chart 2, as an alternative of evaluating estimates on the idea of the identical ‘PCAF’ boundary, I intentionally evaluate financed emissions estimates throughout boundaries for a similar pattern of UK banks as in Chart 1. As I’ve already decided that information high quality and availability has restricted impression in Chart 1, this comparability isolates the extent to which the boundary impacts estimates.

Chart 2: Affect of boundary on UK banks’ financed emissions estimates

Sources: Banks’ climate-related disclosures and annual studies, MSCI and LSEG.

Increasing the boundary from ‘Minimal’ to ‘PCAF’ (A) will increase the financed emissions estimate by virtually 50%. It’s because the ‘PCA’ boundary captures the vast majority of mortgage guide emissions, whereas ‘Minimal’ boundary solely captures emissions related to a subset of excessive local weather danger loans. This improve is materials as a result of whereas ‘excessive local weather danger’ loans are banks’ most carbon intensive, they characterize a comparatively small proportion of whole loans. That is notably the case for UK banks whose largest exposures are residential mortgages.

Increasing the boundary from ‘PCAF’ to ‘All actions’ (B) will increase the financed emissions estimate by virtually one other 50%. It’s because the ‘All actions’ boundary captures emissions related to the broadest vary of banking actions, together with property beneath administration. This impact is pushed by the biggest banks who undertake asset administration and capital markets actions. The impact is extra restricted for banks which don’t undertake these actions.

Decoding emissions metrics throughout boundaries

Regardless of the variation in estimates of financed emissions throughout boundaries, there isn’t a boundary which is superior. As a substitute, which boundary to depend on ought to rely upon the use case.

In Desk B, I suggest a easy framework for the way emissions metrics with totally different boundaries can proxy for 2 use instances – measuring climate-related monetary dangers and local weather impression. ‘Monetary dangers’ means, for instance, greater anticipated credit score losses on loans. ‘Local weather impression’ means banks’ contribution to local weather change, such because the financing of carbon intensive actions.

Desk B: Insights framework for financed emissions estimates

‘Minimal’ boundary estimates present restricted insights into banks’ monetary danger publicity and impression. It’s because they solely seize a subset of banks’ actions.

‘PCAF’ boundary estimates are essentially the most full proxy for assessing banks’ publicity to local weather monetary dangers. Mortgage exposures are the first transmission channel by means of which monetary dangers will come up. This has been demonstrated in supervisory stress checks such because the 2021 Local weather Biennial Exploratory State of affairs. Whereas different banking actions similar to underwriting and asset administration might expose banks to reputational and authorized dangers, the transmission of those dangers into monetary impacts is oblique.

‘All actions’ boundary estimates are essentially the most full proxy for local weather impression. Banks’ impacts on local weather change usually are not restricted to direct loans and investments. The ‘PCAF’ boundary doesn’t seize oblique impacts. For instance, in managing investments in fossil gas intensive firms, banks facilitate exercise which can contribute to carbon emissions and subsequently local weather impacts.

Conclusion

Variations in financed emissions estimates are brought on by variations within the estimate boundary, not information high quality. Transparency concerning estimate boundaries is due to this fact important for interpretation of financed emissions metrics. No estimate boundary is finest, with every providing insights into totally different use instances. The ‘PCAF’ boundary finest proxies for banks’ publicity to monetary danger, whereas the ‘All actions’ boundary finest proxies for banks’ local weather impression. The PCAF boundary ought to due to this fact be utilized by central banks in understanding local weather monetary dangers, in addition to in their very own monetary operations. Nonetheless, all emissions-based metrics are finally proxies. For monetary danger functions, they need to be supplemented with extra subtle instruments similar to state of affairs evaluation.

Lewis Holden works within the Financial institution’s Monetary Danger Administration Division.

If you wish to get in contact, please e-mail us at [email protected] or go away a remark beneath.

Feedback will solely seem as soon as authorized by a moderator, and are solely revealed the place a full title is provided. Financial institution Underground is a weblog for Financial institution of England employees to share views that problem – or help – prevailing coverage orthodoxies. The views expressed listed below are these of the authors, and usually are not essentially these of the Financial institution of England, or its coverage committees.